The U.S. stock market largely found itself in a choppy state this past week, which from a tactical perspective is primarily making me focus on staying away from low-probability stuff, i.e. avoiding fighting any trends and being more selective with trades and reducing position size.
As I laid out in this column last week, the month of August has an above-average tendency of being binary in terms of its performance, as random spikes of volatility are not uncommon. Yet absent a volatility shock, the vacation month of August can also be one of the biggest bores all year.
Without a volatility spike, August perfectly represents an environment where many traders deplete their capital and their mental well-being as they frantically search for opportunities that simply aren’t there. I continue to reiterate to Clubhouse members that above all, this environment requires us to be patient, stick to the process and profits will be a natural side product.
Over the past two weeks we have seen transportation stocks and small-cap stocks (among others) turn near-term bearish as per The Steady Trader proprietary scanner, which in part contributed to a choppy broader stock market. Since transports and small caps flipped near-term bearish, they have dropped about 5% and 1.9% respectively.
Yet it is important to note that most stock sectors of the S&P 500 as represented by the SPDR S&P 500 ETF Trust (NYSEARCA:SPY) remain bullish in both the medium- and longer-term time frames.
Moving averages legend: red – 200 day, blue – 100 day, yellow – 50 day
On the above chart I plotted the SPY in the top half and the iShares Russell 2000 Index (ETF) (NYSEARCA:IWM) at the bottom.
The SPY ETF near-term resistance is $248 and near-term support is around $245.60. In this choppy environment I would not use these levels as my only risk parameter, yet if either of these levels get pierced we could see more follow through higher or lower.
The IWM ETF, for its part, while notably underperforming over the past couple of weeks remains trading in its year-to-date channel and is not something I am looking to touch on the long side until we see a fresh and strong bullish reversal. Again, the name of the game as always but particularly here in the early innings of August is to primarily stay away from low probability stuff and respect the choppy market.
While the broader market has been choppy, underneath the surface the financial stocks as represented by the Financial Select Sector SPDR Fund (NYSEARCA:XLF) has shown promising signs of life in both absolute and relative terms that the aware market participant will want to respect. In other words, the sector and group rotation game that I have been pointing to over the past few months is quietly continuing. Although the XLF ETF has made no progress since it topped out in early March, the rally since did lead to a marginal breakout move last Friday.
As I often discuss in this column, the financial sector is one of the very most important sectors to watch. The financials have been a pain trade all year for investors as interest rates remained choppy, but this may be in the process of coming to an end.
Moving averages legend: red – 200 week, blue – 100 week, yellow – 50 week
On the above multiyear weekly chart, I plotted the XLF ETF at the top and in the bottom half a ratio chart of the XLF ETF divided by the SPY ETF. Note that both are currently snug at the upper end of resistance lines and thus look giddy to break higher. In other words, financials are displaying both relative and absolute strength which could pop past resistance lines in coming weeks or months.
As a result The Steady Trader proprietary market scanner algorithm has seen more and more banking stocks such as JPMorgan Chase & Co. (NYSE:JPM) flip to near-term bullish and into possible breakout mode.
In conclusion, while I primarily want to respect the potential for August to be a quiet and choppy month with a possibility for a random volatility spike or two, we must also continue to respect the sector rotation taking hold as that is where alpha has been generated from all year. The financial sector looks to be one of the best bets to play this sector rotation game as a breakout in both relative and absolute terms is in the cards.
Check out Serge’s Trade of the Day for Aug. 7.
Today’s Trading Landscape
To see a list of the companies reporting earnings today, click here.
For a list of this week’s economic reports due out, click here.
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